Future And Options Derivative Trading For Beginners

Introduction to Derivative Market

Derivative Market

Derivatives are tradable products whose price is based upon another market.Derivatives are security, whose value based upon other more basic
underlying variables.

Mejor Types of Derivatives Contracts

1.    Forward Contracts
A forward contract is a simple derivative security. It is an agreement to buy or sell an asset at a certain time for a certain price.
2.    Futures Contracts
A future contract is like a forward contract. It is an agreement betweentwo parties to buy or sell an asset at a certain time in the future for a certain price.
3.    Options contract
An opinion contract is an agreement between a buyer and seller that gives the purchaser of the option the right to buy or sell a particular asset at a later date at an agree upon price.

Futures and Forwards:

Futures are contracts for agreement to purchase or sell set of assetsat allocated time in the future for a certain amount. Forwards are a type of future which is not standardized and are not traded on the stock exchange.

Options and Swaps:

These contracts are similar to futures and forwards, the only difference being once an options contract is purchased, terms of agreement may not be held.

Participants in Derivative Market

The participants in the derivative markets can be Banks, FIIs, Corporate, Brokers. Etc.....

                                 He is a person who undertakes a position in
1. Hedgers              future and other markets for purpose of
                                 reducing exposure to one or more types of risk.

                                Speculators are operators who are willing to
2. Speculators       take a risk by taking future position with the
                                expectation to earn profits.

                                They are the operators who deal in different
3. Arbitrageurs        markets simultaneously for profit and
                                 eradicate the mispricing of securities across
                                 different markets.

                               He is a person who believes in lower expected
4. Spreaders           return at the reduced risk.

Conclusion

*   The derivatives market is very dynamic and quickly developed into the most important segment of the financial market
*   All in all the derivatives market in Nepal does not have a longer history and thus seems to be still underdeveloped
*   Derivatives play an important role in the economy but are associated with certain risks.
*    The crisis has highlighted that these risks are not sufficiently mitigated in the over-the-counter (OTC) part of the market, especially as regards credit default swaps (CDS). Since the beginning of the financial crisis, the Commission has been working to address these risks.

What is a "Derivative"?

● The term 'Derivative' stands for a contract whose price is derived from or is dependent upon an underlying asset.
● The underlying asset could be a financial asset such as currency, stock and market index, an interest bearing security or a physical commodity.
● As Derivatives are merely contracts between two or more parties anything like weather data or amount of rain can be used as underlying assets.

Indian History of derivatives

The Bombay Cotton trade association started future trading in 1875.
In 1952 the government banned cash settlement and option trading.
In 1995 a prohibition on trading options was lifted.
In 1996, NSE sent a proposal to SEBI for listing exchange traded
derivatives.
In 1999, the Securities Contract (Regulation) Act of 1956 was amended and derivatives could be declared "securities".
Index future were introduced in June 2000 and Index option in 2001.
NSE started trade in future and option by 2005.

ECONOMIC FUNCTIONS OF THE DERIVATIVE MARKET

■ Help in discovery of future as well as current prices.
■ Helps to transfer risks from those who have them but do not like them to those who have an appetite for them.
■ With the introduction of derivatives, the underlying market witnesses higher trading volumes.
■ Speculative trades shift to a more controlled environment in derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets.

DEMAT Account

■ A DEMAT account is opened on the same lines as that of a Bank Account.
■ Prescribed Account opening forms are available with the DP, needs to be filled in.
■ Standard Agreements are to be signed by the Client and the DP.
■ In case of Corporate clients, additional attachments required are - true copy of the resolution for Demat a/c opening along with signatories to operate the account and true copy of the Memorandum and Articles of Association is to be attached.

Why do we need Derivative ?

■ Typically we use derivative for
   ● Hedging - To protect our investment in an adverse market condition.
   ● Arbitrage - Exploiting the mispricing. In other word it is termed as 'A Free Lunch'
   ● Speculation - Taking Directional Bet

DERIVATIVE

●    Derivative is a Instrument whose value is derived from one or more underlying
●    Curd is a derivative of milk, Petrol is a derivative of crude.

Definition:

Derivatives are financial instruments which derive their value from one or more underlying assets.
●   The underlying Instruments could be stocks, indices, commodities, etc
●   Derivatives Instruments are legal contracts. All specifications are pre defined and binding Specifications like - Price, validity, quantity, quality, rights & obligations of participants

Why Do We Call Them Derivatives?

● They owe their existence to the presence of a market for an underlying asset or portfolio of assets, which may be considered as primary securities.
● Consequently such contracts are derived from these underlying assets, and hence the name.
● Thus if there were to be no market for the underlying assets, there would be no derivatives